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What Will Happen To Facebook Stock
The investor has owned Facebook stock for years--since it was a small private company.
But the investor has also been shoveling his shares out the door for years. So much so that he no longer owns much.
Why?
Because the investor thinks the same thing will happen to Facebook that has happened to other big technology companies.
Now that the company's "momentum years" are behind it--the years in which the company's results astounded naysayers and blew away expectations--the investor thinks Facebook's stock multiple is likely to continue to contract, even as earnings continue to grow.
Let me explain that.
Stock prices are a function of two variables:
- Earnings per share
- The price the market places on those earnings per share (the "multiple")
In the years in which a company is growing frantically and blowing away consensus expectations, the market generally assigns a very high multiple to earnings.
Eventually, however, the company matures, growth slows, and the market's expectations come into line with reality.
And as that happens, the stock's multiple contracts.
Why is this relevant for Facebook?
Facebook revenue growth.
Google, in contrast, was much smaller when it went public. So much of the stock upside that that would have accrued to Facebook if it had gone public when Google did has already been captured by Facebook's early investors (whereas, in Google's case, the post-IPO upside was captured in part by public-market investors).
The market's expectations for Google, meanwhile, came into line with reality in 2007...and the stock has basically moved sideways ever since.
As we'll show in charts below, Google's earnings have increased a huge amount since 2007, but the stock's multiple has contracted.
So Google has now been "dead money" for more than half a decade.
The investor I spoke with thinks the same thing will now happen to Facebook's stock.
He doesn't think Facebook is a disaster, or anything. In fact, he thinks it's an excellent company. He just thinks that the market is overestimating Facebook's future growth prospects, and that, as the market gets more sober, Facebook's stock multiple will contract.
In other words, the investor thinks that, although Facebook stock will go up and down (just as Google's has), it will basically be "dead money" for years.
Let's look at some charts that illustrate this multiple compression phenomenon.
Here's a chart of Microsoft's stock over the past 20 years. It did well in the 1990s, then got cut in half when the bubble burst. And it has now moved sideways for more than a decade:
Yahoo Finance
Meanwhile, here's a look at what was going on under the Microsoft hood.
Our data god, Eric Platt (@EricGPlatt--follow him), put together the following chart on Microsoft's earnings (using EBITDA as a proxy) and stock multiple (PE ratio).
As you can see, Microsoft's earnings (red) have increased steadily over the past decade. But its stock multiple (blue) has relentlessly contracted.
And here's another: Google.
Google's stock rose steadily for its first four years as a public company. Then, when the company's results stopped blowing away Wall Street, the stock's multiple started to contract. And Google has now moved sideways for 5 years:
Yahoo Finance
Meanwhile, under the hood...
Google's earnings (red) have continued to grow steadily. Google's PE multiple (blue) has steadily contracted.
So, what's going to happen to Facebook?
Well, eventually, almost without question, the same thing is going to happen to Facebook that has happened to Microsoft, Google, Apple, Cisco, and every other big tech company that once carried a huge "momentum" stock multiple:
The multiple is going to contract.
Right now, Google, Apple, and Microsoft are all trading at low earnings multiples relative to trailing 12-month earnings--17X, 14X, and 10X, respectively.
Facebook, meanwhile, even at $28 per share, is trading at 70X trailing earnings, and more than 35X an aggressive estimate of next year's earnings.
Eventually, Facebook is going to trade at the same compressed multiple is Google, Apple, and Microsoft.
The only question is "when?"
My investor friend thinks that we're already in the early stages of Facebook's multiple compression. Over the next several years, he thinks, Facebook's earnings will continue to grow... but Facebook's multiple will continue to compress.
And the end result, he thinks, is that Facebook's stock will be trading around the same level in 5 years as it does today.
In other words, when the stock chart below is extended into the future, he thinks, it will be Facebook's private-market investors who captured all of the high-multiple "momentum" upside...while public-market investors climbed aboard just in time to ride out the Great Multiple Compression.
Read more: http://www.businessinsider.com/facebook-stock-outlook-2012-6#ixzz1wZC3MGxZ
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